May 28, 2010

Tim Courtney decided he'd had enough. In meeting after meeting earlier this year, he and his colleagues at Burns Advisory Group had recommended mutual funds to prospective clients, only to be hit with the same response almost every time: Why are you telling me to invest in a three-star rated fund?

That sums up the way many investors allocate money to funds -- look at products that have four- or five-star ratings from investment researcher Morningstar Inc., take that as a seal of quality, and hope for the best. Such decisions are perhaps even more common in volatile markets, when anxious investors view top-ranked funds as somehow better-equipped to handle adversity.

The trouble is that investors seem to forget that star ratings are backward-looking, based on a fund's past performance, and studies have shown the ratings have no predictive value.

"Having to get over that hurdle [of explaining that star-ratings shouldn't influence choices], every time we recommended a fund that wasn't five-star, is something we have to do time and time again," said Courtney, chief investment officer of Burns Advisory, which manages about $300 million and advises about $150 million of 401(k) assets.